Today the percentage of households in America and worldwide that own stocks has increased substantially. Either through pension funds, 401K plans, mutual funds or purchase of individual stocks, most homeowners participate in varying degrees in the equity market. More recently, many investors who previously purchased actively managed mutual funds now purchase stock index funds that acquire and hold securities that mirror the performance of some equity index, e.g. S&P 500, Russell 2000, or a sector specific index, technology, or funds balanced to reflect movements in both debt and equity. In short, Americans and other worldwide investors have become financially sophisticated investors with an understanding of stock markets, mutual funds, and the alternative types of fund investments available. For example, recognizing research that indicates that most investors cannot beat the performance of the stock market overall, and that over 80 to 90% of the actively managed mutual funds do not outperform passively managed index funds, Americans have increased their purchasing of stock index funds substantially. Many Americans now regard these indexed fund investments as the safest, most liquid, and prudent way to invest for stock appreciation rates of return over time.
Currently, most investment funds are sold by and managed by stock brokerage firms, mutual fund firms, and money management organizations. The money management organizations may be independent or part of another financial service institution, e.g. a brokerage house or a commercial bank. Current banking and securities laws require that the offerings and disclosures relating to the funds, whether offered by a brokerage firm or a commercial bank, ensure that the customer does not believe that the accounts are insured by the Federal Government.
Margin accounts for investments are well established and regulated by the appropriate margin account limit for collateral as a percent of fair market value set by the Federal Reserve Board, which limit is applicable to all commercial banks, savings banks, and brokerage houses. At present a customer can borrow up to 50% of the fair market value of the customers portfolio held by the mutual fund company or the brokerage house to be borrowed and used for other purposes, including reinvesting the loan proceeds in the account. Because neither the mutual fund company nor the brokerage firm is in the business of making margin loans on a wide scale, the loans are relatively expensive, and under current income tax laws the interest is not always tax deductible by individual taxpayers.
While they have the legal authority, commercial and savings banks have not been in the primary business of making margin loans against securities. And, while most banks or bank holding company's have the legal authority to offer their customers brokerage services and mutual funds, they have only been partially successful, since it is not the central focus of their business. Cross-selling financial services products has been largely a failure in almost all instances in which it has been tried in banks, insurance companies, and brokerage firms. The products are regarded as different and typically require two separate sales forces either by law or practice.
Since the change in the Internal Revenue Code in 1987, a major business for banks has been the offering of secured mortgages, known as home equity lines of credit or home equity loans. Interest on these loans is tax deductible against other income for loans totaling up to $100,000 per couple on primary and/or secondary homes (up to their fair market value). These loans have proliferated and are offered widely through television and other advertising. Some of these loans, combined with the first mortgage result in for a loan to value ratio of 100% or even 125% of the fair market value of the house that is mortgaged.
The bank to which a customer applies for a home equity loan considers or evaluates the use of the loans proceeds in making its underwriting decision. For example, home remodeling, which is assumed to increase the value of the house as underlying collateral, is favored by bank lender and their regulators. Similarly, the consolidation of credit card debt to reduce monthly after-tax debt payments is favored. In credit card debt consolidation, the interest paid on the home equity loan is tax deductible within the limitations above, whereas interest on credit card debt is not. This use of loan funds is considered as making the borrower more creditworthy since a higher proportion of monthly interest payments are now tax deductible when the home equity line is used to pay off the credit card debt and therefore, all other things being equal, the borrower should have more after-tax cash flow remaining for the same or less pretax dollars of interest payments.
Home equity loans are often advertised or marketed to homeowners with high credit card debt and the use of the proceeds from the loan is specified for this purpose. The process of applying for a home equity loan through a bank is complex, time consuming, and must be completed prior to the time the bank can fund the loan. Today home equity loans are offered by banks through their branch offices, by mail, over the telephone, and some banks solicit and accept applications over the Internet. However, all home equity loan applications eventually entail paper delays, consumer inconvenience, normal banking intimidation and a detailed inquiry as to the purpose of the loan. In short, today's home equity loan process is not automated, is not simple, is intimidating and the applicant receives no value or financial benefit until the entire process is completed.
Currently the process of obtaining a home equity loan is standardized, with the borrower having little say over the duration, terms, or interest payment process. For example, banks cannot permit interest on the loan to be accrued, and still have the loan classified as a performing loan on review and examination by the banking regulators. Hence the customer or borrowers choices are circumscribed. Additionally, the process is detailed and sequential with many opportunities for errors on the part of the customer or the bank, which result in a delay in the customer's loan application processing and the loan underwriting process. Should errors occur, manual intervention and investigation is necessary, further delaying the processing of the loan application. Moreover, the consumer must wait until all of the required steps are completed before the loan is funded and disbursed, which is the first time there is any tangible benefit to the customer. This lag between initial application and consumer benefit can be several days, but is typically weeks.
Most banks offer relatively standardized home equity loan products with the customer having limited opportunity to customize the duration, terms, or interest rate components of the loan offered by the bank. Typically, the only three important terms will be whether the rate is fixed or floating, the duration of the home equity loan, and the interest-only period before principal amortization payments start. While the consumer may request one of these features, the bank ultimately determines the terms and conditions of the home equity loan it is prepared to make, and most consumers have little choice or influence over the terms or method of payments for their home equity loan.
For most homeowners, their house is their largest single investment. Therefore their home equity is their largest single asset, but is not a liquid asset so long as it remains untapped. While the overall value of a homeowner's house may appreciate in value 2–6% per year on average for the country, this is far below the long-term average appreciation in the stock market of 12.5% per year. At a 4% rate of appreciation the initial value of a homeowners equity will double in approximately 19 years. At 12.5%, the same initial value will double in 5.5 years.
The present commercial banking laws, dating back to the Glass-Steagal Act in 1930's, make it cumbersome, slow, error prone, and time-consuming for a consumer to utilize the accumulated equity in their house as collateral to borrow to invest in equity-like funds or financial instruments that allow the homeowner to conveniently utilize the equity in their house to achieve an equity return in that currently dormant uninvested asset, which is typically the homeowners largest single asset. There is no easy, automatic, and convenient process in one transaction to use one financial service product or account that allows the customer to conveniently employ their home equity to increase their investments on a tax-favored basis by having the interest on an investment account be tax deductible.
At the present time, there is no single integrated financial services product or account that exists that provides for a home equity loan and an ability to customize the account so that the customer can pre-select or choose both the investment fund's asset mix to be purchased, and customize the account, plus having certain performance benchmarks chosen by the customer that when met or exceeded, will trigger an alert, such as a voice call or electronic message to the account owner.